Dabblers and dawdlers beware: Despite lingering uncertainties about exactly how to approach offshoring, it could be even riskier not to jump in.

Peter Lowes, Principal, Deloitte Consulting LLP (Nov 06)

Offshoring by financial institutions is no longer a fledgling experiment in efficiency. Unmitigated pressure on margins and relentless competition have made offshoring a virtual necessity in today's marketplace. And while many leading financial companies enthusiastically embrace it to achieve superior and sustained performance, others remain reluctant to dip even a toe in the water.

Over the past decade, we have seen two key forces emerge as leading approaches to help build investor confidence by restructuring operations for greater efficiency: (1) re-engineering of onshore business processes; and (2) moving parts of a company to lower-cost locations on other shores. Both work, and even though the former started out with the advantage of greater familiarity, offshoring has established itself as a common practice throughout the financial services industry in a relatively short period of time. Increasingly, the issue with offshoring is that it is no longer in its infancy, but it's not fully mature either; so its benefits and impact have varied widely among companies that have tried it over the past decade or so.

Research DataIn a recent survey of 62 leading financial companies around the world - conducted by Deloitte Touche Tohmatsu Member Firms' Global Financial Services group - the current state of offshoring in the financial services industry was examined, as well as the question of what companies should consider going forward to make the most effective use of offshoring's potential. The participants accounted for one third of the global top 100 companies by market capitalization, as well as many smaller and privately owned companies. This was the third year that the in-depth survey has been conducted in an effort to provide financial services companies with a global benchmark of trends and results factors.

The latest survey indicates without question that offshoring has momentum, with 70 percent of survey respondents either offshoring at present or planning to do so. Growth in scale was also marked, increasing from 25 percent of all respondents in 2003 to 70 percent in 2005.

So how big is the current offshoring opportunity for financial services companies? According to our research data, the industry as a whole could triple the cost savings from its offshore operations if every company with an offshore presence were to match the scale and scope of the top performers. Using Deloitte `s annual benchmark of offshoring practices as a basis, the participants in the Deloitte Touche Tohmatsu survey could potentially reduce their annual cost base by up to $16 billion - from currently around $5 billion. The source of these additional benefits would come from two primary activities: scaling headcount and expanding the scope of operations to "full service," which means the offshore relocation of all types of functions - not just IT and back-office activities.

But outcomes and results have varied, suggesting that companies are still searching for the most effective way to do things and that the actual practices for where and how to operate effectively offshore are still maturing. Nearly a third of survey respondents - up from about 20 percent in 2004 - have chosen to remain firmly ensconced onshore. The majority of those electing to stay at home are smaller players that are focusing their cost-control efforts on re-engineering onshore processes and reducing headcount. Many of these respondents also expressed deep-seated concerns about the true benefits of moving parts of their companies to new lands, e.g., reduced quality and flexibility, adverse reactions from the public, and whether potential cost savings would justify these trade-offs.

Offshoring at the CrossroadsThe results of this year's survey underscore offshoring's rapid evolution and the critical juncture at which the industry finds itself today. Overall, the survey indicates that development of offshoring in financial services has reached an inflection point, where winners and losers can be determined rapidly. On the one hand, major players need to be offshoring more than just a little bit; they need to do it at a much greater scale. In addition, they must institutionalize their offshoring operations, managing them well and embedding leading practices into the company's culture. Even some of offshoring's pioneers may be in danger of losing ground if they don't focus on aggressively expanding scope and scaling headcount while streamlining their systems and processes. Those companies new to offshoring, or planning to offshore, have the opportunity to rapidly adopt newly emerging leading practices from industry leaders.

As with any situation that is in flux, the current state of offshoring offers tremendous opportunities for those companies that act decisively, while those that hesitate (dawdlers) or steer an errant course (dabblers) may find themselves irrevocably behind. While the survey didn't reveal any clear consensus on leading practices for operations or competitive strategies, it did point to several areas of key interest, which we have come to regard as critical factors in achieving expected results.

Factors that Can Impact ResultsThe primary challenge today is to take offshoring to the next level by improving operational efficiency. Despite the diversity of strategies that exist in the marketplace, we have identified four major elements to help achieve desired offshoring results that can apply to companies of all sizes and at all stages of offshoring development: complexity, cost, compliance, and culture - as well as the venerable "enabler" of all four: location.

1. Complexity: As companies race to scale their operations, they will need to find ways to manage complexity. "Bigger isn't necessarily better" if it results in complicated business processes and a tangle of procedures and reporting mechanisms. Simplicity and efficiency are the keys to unlocking the economies of scale and scope. That's why companies should constantly work to streamline their operations, while simultaneously migrating activities offshore. The most experienced "offshorers" understand this dual challenge and do not automatically take their existing systems and processes and simply move them abroad. Instead, about half the companies that have been offshore for more than five years deploy a "re-engineer then move" strategy, while the other half employ the "move then re-engineer" (or "lift and shift ") method to relocate activities.

In the 2005 survey, financial companies displayed a preference for a hybrid, or blended, approach that mixes both captive and outsource providers. This combination is capable of providing offshorers with the "best of both worlds" by blending the flexibility of outsourcing with the direct savings and control of a captive model.

Nearly 50 percent of the respondents that offshore now in some way employ a hybrid model, and most of them have been offshoring for more than three years. Experience has apparently taught these respondents that "one size does not fit all" concerning the most effective approach for different offshoring situations. In addition, more than half of the respondents that are still in the planning stages also intend to follow a blended approach, suggesting that the hybrid model may now be emerging as a standard practice and that both new and experienced offshorers are becoming increasingly sophisticated when it comes to balancing fixed and variable costs.

2. Compliance: While the survey revealed that top operational and regulatory risks varied widely, the respondents unanimously agreed that the top "people challenge" is ethics, which ranked higher than wage inflation, job experience, qualifications, and attrition. Issues related to compliance, security, and ethics require another "C-word " to resolve: commitment. Preventing theft, protecting privacy, and complying with regulations across borders generally require extensive management oversight and a formal governance structure.

Equally important, financial services companies should begin to seamlessly integrate their offshore operations with their onshore ones. Having similar policies and procedures at home and abroad can make monitoring and compliance easier. In addition, promoting a holistic vision within the company, where remote operations are viewed as being as much of an integral part of the company as those at home, helps provide the foundation for establishing a global ethic that can transcend culture and national boundaries.

3. Culture: A truly "global" operating model requires top-of-mind awareness and hands-on involvement from senior management. This means that companies should find a way around "offshoring fatigue." While offshoring might be an exciting strategy for a company at the beginning, like most things it can lose its luster over time. Typically, offshore operations start out "under the microscope." Offshore resources perform well and missteps are rapidly corrected while the company's leadership closely monitors the operation. But oftentimes these benefits can diminish rapidly as the offshoring program becomes "business as usual," and management turns its attention to other matters.

Another problem has been that top talent is often unwilling to move or stay abroad for long assignments. One alternative companies should consider to address this issue is a "tour-of-duty" approach, making time abroad a standard part of the management fast track, rotating top talent in and out to maintain a healthy mix of experienced management and fresh talent. This "tour-of-duty" approach can help financial services companies in their efforts to achieve the critical objective of creating an organizational culture that extends beyond national boundaries.

4. Cost: All of these elements demand a substantial financial commitment. All too often offshorers focus on short-term cost reduction as the primary goal. This narrow view is usually not enough to achieve the scope and scale that is becoming increasingly essential to sustaining savings over the long term. Companies should continuously reinvest some of their short-term savings into application of leading practices if they are to extend and enhance the benefits of outsourcing. Consequently, balancing short-term investor demands and long-term strategic development is imperative.

The Important Role of Location SelectionAs
mentioned earlier, the location selected for offshoring can widely
influence all four of the results factors, especially when operating in
a hybrid or in-sourced model. It certainly figures into cost
considerations, but also can significantly impact the complexity of
planning and implementation arrangements, the ease or difficulty of
meeting compliance requirements, and the level of challenge posed by
cultural adaptation - both to locals and to prospective recruits for
offshore assignments.

Location selection criteria typically
should focus heavily on the scalability and sustainability of
operations in a particular geographic location. This is especially true
when it comes to assessing availability of skilled labor and other
talent, the sophistication of required infrastructure - or lack thereof
- and the perceived (versus actual) risk of operating in the local
business climate. All of these factors should be evaluated against the
cost of similar operations in alternative locations using a process
that iteratively screens, analyzes, and investigates all countries,
cities, and localities that could be considered. Some companies are
finding that a globally distributed workplace model is a helpful
planning tool for assessing and balancing the opportunities and risks
of offshoring against more traditional options, such as choosing
onshoring or near-shoring locations.

In addition, as experience
with offshoring matures, newcomers and those exploring expansion
opportunities should bear in mind that some of the more popular
locations are now well treaded. Major Indian cities would fit this
category, for example. Location selectors should weigh the challenges
posed by potentially co-existing with competitors in a well-known and
tested offshoring environment versus pioneering in an emerging location.Sooner or Later.We believe that there is no time to waste. Offshoring is maturing so rapidly that companies slow to act may expose themselves to undue competitive risks. Onshorers, on the other hand, potentially face the most significant challenges. So far, those who have chosen to remain onshore have stayed competitive through aggressive process improvements and cost-cutting. However, at some point onshore players will exhaust their improvement opportunities and have no other way to cut costs, potentially putting them at competitive disadvantage. Acquiring other companies or using shared services in back offices to gain economies of scale may stave off margin pressures for a while, but sooner or later they will very likely need to address the growing cost gap between themselves and offshorers that are operating from a lower-cost base. Later, in this case, just may be too late.

Whatever the situation, the main message is clear: dabblers and dawdlers beware. Offshoring is here to stay and it should be pursued with commitment and enthusiasm. Effective financial services companies of the future have little choice other than to dive in and swim energetically toward the competitive advantages that lie on other shores.

Peter Lowes is a Principal at Deloitte Consulting LLP in New York, where he leads the Outsourcing Advisory Services practice. He has led or advised on outsourcing and offshoring transactions valued at over $14 billion in aggregate revenue. He can be reached at (212) 618-4380.

Note: This publication contains general information only and Deloitte Consulting LLP is not, by means of this publication, rendering business, financial, investment, or other professional advice or services